Carbon Pricing at COP21

From a business perspective, carbon pricing at COP21 is arguably the most exciting news to emerge from the first few days of the conference. Day one of the United Nations Framework Convention on Climate Change in Paris included a high-level press conference which called on the world’s governments to begin proposing carbon prices as a policy tool to dramatically impact greenhouse gas emissions. The Carbon Pricing Panel, convened by the World Bank president and the managing director of the International Monetary Fund, simultaneously launched the Carbon Pricing Leadership Coalition, which comprises over 80 partners from all sectors, including governments, civil society actors, and private companies. The coalitions argue that a carbon price provides the best opportunity to successfully scale up renewable energy innovation and investment in clean technology, all the while continuing to push world economies forward. As World Bank President Jim Yong Kim states, “there has never been a global movement to put a price on carbon at this level and with this degree of unison.”

What is Carbon Pricing?

Carbon pricing is the idea of establishing a cost for the amount of carbon emissions one produces. The price set on carbon is the price one pays for emitting a single metric tonne of carbon dioxide equivalent. Putting a price on carbon has become a common point of discussion over the past few years, and is often recognized as the most favorable market mechanism to address global climate change and reduce greenhouse gas emissions. Carbon pricing seeks to internalize many of the costs of emissions that are now considered externalities. These externalities are costs that the public incurs from indirect measures, including deaths from air pollution, reductions in crop productivity, and losses due to climate change-induced natural disasters. By placing a cost on each ton of carbon emitted, governments can internalize and fully account for the entirety of carbon related costs. Simply put, a carbon price shifts the burden of climate change related costs back to the original emitter, as opposed to the public. There are two primary carbon pricing mechanisms: emission trading schemes (ETS) and carbon taxes.

ETS sets a cap on allowable emissions, and slowly lowers that cap overtime. Companies and other actors are given a limited number of tradeable emission permits, which also expire overtime. Actors who emit little greenhouse gases are allowed to sell their remaining permits to those who emit more, creating a supply/demand market that effectively establishes a price on carbon. Overtime, as the emission cap falls and permit prices rise, actors are forced to lower their emissions in the most cost-effective and efficient way possible.

A carbon tax, on the other hand, sets a direct price or tax rate on units of carbon emissions.

What are the benefits of Carbon Pricing?

Carbon pricing is highly favored by economists as an effective means to reign in on uncontrolled emissions. This pricing mechanism has proven to be incredibly effective in primarily two ways: protecting and improving our environment, and raising revenues. By forcing private and public sector actors to pay for each ton of carbon they emit, businesses and individuals will naturally seek the lowest-cost way to reduce these emissions. While carbon pricing is arguably no where near the price level or geographic coverage needed to be globally effective, a rising carbon price means that more and more actors will continue to reduce emissions in order to avoid added costs. At the same time, the collected revenue from a carbon pollution reduction scheme can have transformative impacts on national economies. This added revenue can be used to cut capital and labor costs, contribute to environmental protection, mitigation, and adaptation, or be funneled directly into renewable energy projects to progress the transition to a sustainable economy. At a COP21 high-level side event, experts from the IMF noted that a $30/mtCO2e (metric tonne of CO2 equivalent) can increase national Gross Domestic Production (GDP) by 1-3%.

What’s Next?

While it has been explicitly noted that the Paris COP21 Agreement will include no set price on carbon, the language in preliminary drafts sets the stage for countries to begin implementing carbon pricing mechanisms. Currently, close to 40 countries and at least 20 cities, states, and provinces have established carbon pricing mechanisms, including the European Union, regions of the United States, and China. Over half of the Intended Nationally Determined Contributions (INDCs) make reference to the implementation or importance of carbon pricing mechanisms in the near future. In addition to national and regional governments, 435 companies now use internal carbon pricing to effectively and transparently internalize the costs incurred due to greenhouse gas emissions. The Paris agreement should effectively recognize that significant carbon market activity already exists, and encourage nations to help facilitate the development of such markets. World governments must and will set carbon price signals that indicate future carbon prices. COP21 should similarly provide assurance that markets are associated with high environmental accountability and that careful measures are taken to ensure emissions are effectively monitored.

However, this will be no easy feat. Some national governments, lead by the charge of the Bolivia delegation, are wholly opposed to the concept of carbon pricing, based on a philosophical objection to the commodification of nature and the effectiveness of market-based solutions. Still, individual nations, corporations, and local governments have already indicated the importance of carbon pricing. As coverage continues to expand and prices stabilize, carbon pricing will quickly emerge as a top mechanism to reduce global greenhouse gas emissions, mitigate harmful climate change, and drive a new green economy.